Stephen Cauchi

At Sydney’s Old Fitzroy Hotel, proprietor Garry Pasfield recalls one evening when the value of a bitcoin went from $995 to $1072 in four hours. Those who bought beers in the digital currency at the start of the night were slightly miffed.

‘‘It fluctuates a hell of a lot,’’ Pasfield says. ‘‘Sometimes an $8 beer will cost them $7.20, another time it might cost them $8.50. They consider it a bit of fun. I see them going, ah – it cost me $8.20, bugger it.’’

'Sometimes an $8 beer will cost them $7.20, another time it might cost them $8.50'

It may be fun, but if the bitcoin spent last month on a round of beers can now buy a television, it ceases to be. And that’s a real risk with the currency. Released in 2009, the bitcoin traded cheaply at first – under $US10 in 2011 and 2012 and at $US100 as recently as last October. It then soared as investors sensed its potential, reaching a record $US1241 on November 29. It dived back under $US700 after China barred the country’s banks and payment systems from trading in the currency, and it now hovers around $US870.

The opposite of central banking

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Digital currencies, of which bitcoin is the best known, have been labelled everything from gimmicky to groundbreaking. To their backers, they are the biggest revolution in monetary economics since central banking – precisely because, in many ways, they are the polar opposite of central banking.

With the bitcoin, there is no central depositary or authority. Instead, all transactions are carried out and verified on a worldwide, decentralised, peer-to-peer computer network using the bitcoin protocol and reference software, Bitcoin-Qt. It was designed by a pseudonymous person or group known as ‘‘Satoshi Nakamoto’’, whose true identity remains unknown.

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To prevent double-spending of bitcoins and other fraud, the network keeps a public record of worldwide bitcoin transactions in chronological order. Known as the ‘‘block chain’’, this record is updated every 10 minutes and cannot be reversed.

The volunteer computer programmers who crunch the complex mathematics needed to maintain and update the block chain are known as bitcoin ‘‘miners’’. The bitcoin program pays the miners for their services by paying them freshly created bitcoin. This is also how new bitcoins are released into circulation.

The software is designed to release bitcoins at a decreasing rate over time until there is a final worldwide supply of 21 million. As of last year, about half the total supply – 11 million – had been generated. By 2017, three-quarters will have been generated. Finally, in 2140 – over a century from now – the last bitcoin will be released.

A bitcoin is also divisible to eight decimal places (one hundred millionth of a bitcoin is known as a satoshi), which enables small and micro payments. Purchasers are given a virtual bitcoin ‘‘wallet’’ and can buy their bitcoins at exchanges such as Mt.Gox and Coinbase.

Enormous hurdles

There is no data on Bitcoin’s share of Australian transactions but it is undoubtedly minuscule – 1 per cent or below, Bret Treasure, founding board member of the non-profit Bitcoin Australia, says. But he is optimistic. ‘‘Everybody who is in this space loves the idea that one day it’s going to become a mainstream transaction mechanism,’’ he says.

‘‘Bitcoin Australia would love that figure to be 100 per cent of transactions within a 10-year time span. But things would have to change for that to happen ... there are enormous regulatory hurdles and the volatility of the price makes it very difficult to be taken seriously by the retail sector.’’

But backers of digital currencies are determined to make it happen. Bank fees and profits arouse widespread resentment; the transaction fees on the bitcoin, by comparison, is far less. And it can deliver what right-wing libertarians have long sought: a currency free from the inflationary habits of central banks.

‘‘A lot of people in the bitcoin community don’t like the idea that the government can just print more money when they feel like it,’’ Treasure says. ‘‘They don’t like quantitative easing and they don’t like fractional reserve lending. People who come from a libertarian background are attracted to bitcoin. They are the early adaptors.’’

The banking crisis in Cyprus – when depositors suffered large losses – ‘‘rattled people’’, Treasure says. ‘‘Bitcoin takes all of that away.’’

Lower fees, tax potential

In Australia, where excessive bank profits and fees are universally resented, Bitcoin’s ‘‘dramatically lower’’ transaction fees stand to win wide appeal. ‘‘If you do an international transaction and you’re a public company, you could pay $10,000 in fees. You could do that transaction in bitcoin for $100,’’ Treasure says.

Of course, the world’s governments can kill the currency and China has tried to already, citing the bitcoin’s potential for money laundering. ‘‘Governments have the ability to make it very difficult and some of them will,’’ Treasure concedes. ‘‘But some of them will be a little more far-sighted ... after all, governments will want to tax bitcoin.’’

The Old Fitzroy pub, which accepted its first bitcoin in September, was the first Australian bricks-and-mortar business to use the currency. In Melbourne, St Kilda businesses cafe imbiss25 and music, fashion and jewellery store Eclectico now accept the bitcoin. So too do food and vegetable supplier Earth and Sky Organics, and Oakleigh South all-terrain vehicle manufacturer Tomcar.

Pasfield says bitcoin trade at Old Fitzroy is ‘‘absolutely growing’’.

‘‘We would have a transaction no less than every second day and frequently every day,’’ he says. ‘‘Geeks’’ are the main users. ‘‘It’s because it’s had its infancy in the computer world. They’re the customers we expect and they’re the customers we’re getting at the moment ... About 10 per cent are backpackers, mainly American or Canadian.’’

Transactions are done using the hotel’s tablet and the customer’s smartphone. ‘‘It’s simple,’’ Pasfield says. ‘‘I would compare it to a transaction of EFTPOS. I settle in Australian dollars, within 24 hours.’’

There is a way for merchants to avoid the bitcoin’s volatility, one that Pasfield has taken, by signing up to Australian company Bitpos.

‘‘With Garry, if someone buys something for $6.80, we pay Garry back $6.80 the next day minus our fee (1 per cent),’’ Bitpos founder Jason Williams says. ‘‘Bitcoin as a currency fluctuates quite wildly ... we manage that risk. If a merchant charges $6.80, he’ll get $6.80 back from us regardless of whether bitcoin has halved or tripled. We provide surety.’’

Bitpos, launched this month, is a simple tablet-based program via an internet channel. ‘‘We’ve got a handful of sign-ups so far but we’re getting a couple of new sign-ups every day,’’ says Williams, who is hoping to sign up a well-known hardware manufacturer. He puts the number of bricks-and-mortar Australian businesses accepting the bitcoin at ‘‘20 or 30’’, and a ‘‘couple of hundred’’ online businesses. ‘‘We want bitcoin to be as ubiquitous as Australian dollars.’’

Others don’t. ‘‘Our compliance guys say to stay away from it,’’ a banking analyst says. ‘‘Who likes bitcoin the most? It’s not the most savoury people in the world. That’s why a lot of governments don’t like it.’’

No backing

And there’s more fundamental issues: ‘‘For it to be a currency, it has to be an accepted medium of exchange and in China, for example, it’s not. And that’s the second largest economy in the world. It’s also not backed by anything. It’s not backed by a central bank, it’s not backed by gold. That hurts its acceptance as a medium of exchange.’’

HSBC chief economist Paul Bloxham says the lack of backing is not necessarily a problem.

‘‘It depends on the willingness of people to believe that it is a reliable store of value,’’ he says. ‘‘It’s volatility in recent times is a reflection of the fact that the market can’t quite determine whether it will be a reliable and constant store of value in the future. Digital currencies are new and novel, and investors are trying to determine if they have a long-term future or not.’’

The world’s governments must come to an agreement over digital currencies for them to have a future, Arab Bank of Australia treasury dealer David Scutt says. ‘‘There needs to be a global understanding among regulators that bitcoin is actually acceptable. Until we get that, there’s always going to be question marks over its viability.’’

No dilution

The growth of digital currency is no surprise given what’s happened since the global financial crisis, Scutt says. ‘‘Given what was seen with central banks increasing their monetary amounts over the past few years, yes, I can see why bitcoin’s limited scope and limited amount may be beneficial and why some people see value in it.’’

The very limited issue of bitcoins – 12 million only – means its value cannot be diluted through money printing. For many, this makes the bitcoin not only a reliable medium of exchange, but a solid investment. ‘‘Instead of being used for general day-to-day transactions, people may actually hoard them as a hedge against inflation in fiat currencies,’’ Scutt says.

The problem with hoarding is that it presents the spectre of the bitcoin entering a deflationary spiral. No one will spend a bitcoin they think will be worth far more in future. With no one spending bitcoins, supply plummets; with bitcoins a sure-bet investment, demand soars. Result: hyper-deflation.

Silicon Valley venture capitalist Chris Dixon speculated this month that a single bitcoin might even be worth $100,000 at some point.

In return, bitcoin defenders point out that such spirals – the Dutch tulip mania of 1637 being a prime example – never last and are self-correcting. If people hoard bitcoins, they will cease to be used as a medium of exchange. This will make them, in effect, of no value. A crash or correction is inevitable.

Furthermore, competing digital currencies of the future should, in theory, smooth the fluctuations in the bitcoin’s value. If the bitcoin proves to be too volatile, consumers or traders will switch to a more stable competitor. Although the bitcoin is by far the world’s predominant such currency, others show promise. There are 13 besides the bitcoin worth more than $US1: Mastercoin, Bitbar, Litecoin, Protoshares, Novacoin, Unobtanium, Namecoin, Anoncoin, Peercoin, Primecoin, Franko, Cryptogenic Bullion and Diamond.

Reserve Bank governor Glenn Stevens described digital currency as ‘‘fascinating’’ in a recent interview. ‘‘It might or might not hold its value,’’ he says of the bitcoin. ‘‘I don’t think it has caused us a material problem yet ... but does it become an object of speculation with a lot of leverage behind it like a tulip mania? I don’t know the answer to that.’’

Underworld appeal

Stevens did not refer in the interview to the criminals attracted to digital currency, primarily because of the anonymity involved in setting up an account. China cited money laundering as the reason for its bitcoin crackdown and the currency is also being used by traffickers of drugs, guns, pornography and other contraband. Underground website Silk Road – known as the Amazon or eBay of illegal drugs – required payment only in bitcoin and was shut down by the FBI in October.

Silk Road is not an isolated case. In November, Sydney student Daniel Skelley, 21, died after taking drugs he bought from the websites Sheep and Black Market Reloaded. Both sites accept only bitcoin.

Global regulators may find a currency perfectly suited for criminals unbearable. A National Australia Bank research paper on the bitcoin last month highlighted this problem. ‘‘Its short history so far has mostly encapsulated illegal activity characterised by the deep website Silk Road ... the connection between bitcoin and illegal activity will have to be broken before it becomes widely trusted and accepted.

‘‘While we cannot say that bitcoin will definitely not become a medium of exchange, what we can say is that it will take a prolonged period of time to prove.’’